On-chain Analysis: Everything You Need to Know

On-chain analysis allows investors to monitor blockchain transactions and data to help them make more educated decisions.

This guide covers everything you need to know about on-chain analysis, including how to use it, the key on-chain metrics to look for, and the limitations to be aware of before you make investments.

What is on-chain analysis?

On-chain analysis involves monitoring blockchain transactions and wallet data. Every transaction on a blockchain is recorded and publicly available; on-chain analysis utilizes this raw data to better understand how tokens flow, where assets move, and who is accumulating them and becoming a major holder. With this information (often combined with other analysis methods), investors can make educated investment decisions.

How on-chain analysis works

Blockchains, including major ones like Bitcoin and Ethereum, are all public ledgers, meaning every transaction on that blockchain is recorded and publicly available. This raw data can be difficult to interpret, so blockchain analysis tools use specialized nodes to retrieve the data and present it in a searchable format.

Who uses on-chain analysis?

On-chain analysis can be used by investors, financial institutions, auditors, researchers, and many others, for their own specific needs:

• Crypto investors: They use on-chain analysis to gain an edge in their investments. By monitoring where transactions flow, how active networks are, and whale activity, investors can use this information to make investment decisions.

• Auditing and compliance teams: On-chain analysis can be used to track transactions, to verify the movement of funds, and identify potentially suspicious activity.

• Financial institutions: Large financial institutions can use on-chain analysis to monitor crypto exposure, assess risk, and inform investment decisions.

• Researchers: On-chain analysis can help researchers understand investor behavior, gauge market sentiment, and determine if a digital asset is overvalued or undervalued.

How can on-chain analysis be used?

There are several key metrics that you can use to analyse on-chain data and determine market sentiment. These include:

• Network growth: A growing number of active addresses interacting with the network could indicate user adoption and long-term potential for the network or projects.

• Transaction volume: The total fiat value of the transactions on that network. If a lot of value is being put into the network, you could surmise that there is greater market interest.

• Whale tracking: Whales are entities that hold the most tokens. You can analyze their movements to understand whether they are holding onto their tokens, which could indicate long-term bullish sentiment, or preparing to sell off, which could cause a market downturn.

• Realized profits and losses: Whether the assets that are being moved are at a profit or loss for investors, helping to identify large-scale selling activity and potential market downturns.

• Total value locked (TVL): The total capital that has been deposited into liquidity pools, lending protocols, and smart contracts. A rising TVL can indicate increased network usage, liquidity, and investor confidence, while a falling TVL may suggest reduced participation.

• Network value to transactions (NVT) ratio: An equation that divides network value by daily transaction volume. This number indicates whether a network is overvalued or undervalued.

• Security: Audit and compliance teams can use on-chain data to trace transactions and ensure funds are where they are meant to be.

Limitations of on-chain analysis

On-chain analysis can be a very insightful tool when used correctly, but there are a few limitations to be aware of:

• Cross-chain tracking: Blockchains essentially act as their own, isolated ledger. It can be technically complex to try to track an investor moving funds from one blockchain to another.

• Centralized exchanges: On-chain analysis looks only at data recorded directly on a blockchain, and can miss off-chain transactions happening within centralized exchanges, such as Coinbase or Binance.

• Mixing tools: Services such as blockchain mixing tools are used to enhance privacy by obscuring the path of funds. These methods include pooling and then redistributing funds through mechanisms designed to make flows more difficult to trace.

• Lack of context: Political, economic, and regulatory events can impact cryptocurrency activity. On-chain analysis uncovers the raw data of the transactions, but it lacks the context and nuance of events taking place in the real world. 

• No identity: Unless a wallet address has been explicitly linked to an organization or individual, most addresses have a level of anonymity that makes it difficult for users to identify the owner.

Combine on-chain analysis with other analysis tools

On-chain analysis can be a great tool for investors if used correctly. The best way to utilize on-chain analysis in your strategy is to combine it with other analysis tools and off-chain analysis. This can include studying crypto price charts and trends, as well as understanding the real-world context: i.e., is this token being sold off because of a political or economic event, a scare tactic, or a halving event. Understanding what is happening outside of the blockchain can help you better manage risk before making any trading decisions.

How to do on-chain analysis

Here’s a step-by-step guide on how to conduct on-chain analysis:

1. Select a tool: Interpreting raw data and code can be difficult. You can select an analysis tool, such as Nansen or Arkham, that interprets the data for you.

2. Focus on relevant on-chain metrics: Monitor key metrics, including active addresses, exchange inflows and outflows, and TVL to understand network adoption and where funds are flowing.

3. Track whales: Whales hold large amounts of tokens that can heavily impact markets, so you can track whale activity to determine whether they are holding or selling. 

4. Use other analysis methods: On-chain analysis alone will not give you a complete picture. It’s best to use other analysis methods, such as crypto price charts, and keep up to date with economic, political, and regulatory news to gain more context.

Use a portfolio tracker

Alongside on-chain analysis, a portfolio tracker, like Koinly, can help you keep track of your cryptocurrency investments. Koinly offers a free portfolio management tool to track your transactions, balances, gains, losses, and more.